Contents

NPLs

Servicer consolidation boosts NPL recoveries

The Italian servicing industry is experiencing a strong growth trend. Italian non-performing loan recoveries are expected to benefit as a result.

Sources agree that growth in the servicing industry is the trend with the most positive impact on Italian NPL recoveries, given the widening of the scope of servicer activities and the growth in the volume of servicer-managed NPLs. Many third-party servicers have recently started investing directly and enlarging their capabilities, including Creditech of Mediobanca Group, recently renamed aMBCredit Solutions.

Other players are looking to combine different models, including master servicing (Cerved) and advisory and direct investments (Credito Fondiario). In other cases, NPL management and servicing businesses have been used to develop wider banking services platforms, focused on specialised lending and corporate restructuring (Banca IFIS).

Investor acquisitions in the sector and in horizontal servicer integration are also gaining traction. Some of this year's deals include Bain Capital's acquisition of HARIT, Varde's acquisition of 33% of Guber and KKR's acquisition of Systemia.

Moody's notes that special servicers in NPL transactions typically play a much greater role in determining a securitisation's cashflows versus traditional deals. The critical role played by the servicer is due to the greater need for restructuring loans and enforcing collateral. For historical NPL transactions, recovery rates have been higher when a special servicer performed the servicing duties, rather than the originator.

Banks typically lack the expertise and infrastructure to deal with NPLs, which entails a granular data on claims and specialist IT. "For most Italian banks, credit collection is typically a legal matter, with no culture of credit management and understanding of financial liquidation," says Massimo Famularo, head of Italian NPLs at Distressed Technologies.

The most common route for recovering claims tends to be extrajudicial, whereby servicers negotiate terms with borrowers - although the choice between a judicial and an extrajudicial strategy depends on debt type (secured or unsecured). According to Giovanni Fassari, senior financial analyst at Guber: "Extrajudicial strategies tend to shorten the recovery's timing, since the debtor can maintain ownership of the asset by paying a lump sum. For smaller claims, an additional strategy could be represented by a repayment plan based on the garnishment of a fifth of the salary."

Famularo adds that it's an efficient way to "smooth out the process", since the bid-ask gap on an NPL portfolio disposal can be reduced with the advice of a qualified servicer.

For standard portfolios, the most common incentive scheme is based on a variable fee on collections, which tends to align the interests of servicers and portfolio owners. However, there are different views over the value of the fee.

According to Famularo, a fixed amount could also be considered for portfolios that are more labour-intensive and involve more legalities. He adds though that for granular portfolios and small loans, the focus should be on a variable fee on collections.

For Fassari, the servicing fee remains the most efficient way, since it is basically a success fee. "At the end of the day, servicers are out there to maximise recoveries."

The greatest challenge for Italian servicers appears to be the uncertainty over the timing of collections, thanks mainly to jurisdictional differences and the inefficiencies of the judicial auction. In the case of residential mortgages, for example, the borrower may not allow anyone to see the asset, so the auction may never take place.

Servicers usually overcome these obstacles by either performing an auction in order to increase the number of potential buyers, or setting up REOCOs (real estate owned companies) - SPVs that repossess assets via auctions and evict the borrowers since they are legally no longer the owner. Local regulations usually require REOCOs to be established, as banks typically cannot attend auctions.

Seizing collateral through an auction depends on the collateral and the legal provisions that come with it. Moreover, under this option, creditors can be subjected to capital gains taxes following an asset sale and a reimbursement of all senior creditors.

Overall, Fassari notes that the irregularities in the payments are not a problem. "If the recovery workouts are right, you would know with a certain degree of probability that - despite variable cashflows - you are on average correct."

Understanding the probability of recovery involves a credit analysis with variables, such as geography, percentage of book value related to corporates or individuals, average ticket and collateral assets. The most important factor determining both the probability of recoveries and the quality of the servicers is the business plan, however.

The plan allows for the discounting of cashflows and its features include a quarter-by-quarter timeline for monitoring whether recovery targets are on track. "It provides a clear representation of when gross cashflows, costs and net cashflows occur along the timeline. This, in turn, provides the investor with audited records of recoveries on a real time basis," Fassari observes.

According to PwC, as of year-end 2016, Italian NPL servicers manage approximately €135bn-€155bn of bank NPLs: around €85bn is outsourced by banks (40%-45% of bad loans owned by banks), while the rest (€60bn) is outsourced by investors and other financial institutions that have limited direct servicing capabilities. The firm expects the share of bad loans managed by third-party servicers to rise in the near future, reaching around €200bn by 2018.

PwC attributes this forecast to two reasons. First is the shift of bad loan portfolios from banks to investors: while total bad loans are expected to slightly decrease in the next five years, the increase of disposals from banks to investors will be a key factor for the growth of the NPL servicing market.

The second reason is increased outsourcing from banks due to ECB guidelines on NPL management and GACS legislation, which requires independent special servicers for bad loans securitised under the GACS scheme. This is expected to drive an increased search for specialisation and quality of servicing, providing a boost to outsourcing levels and opportunities for high-quality servicers.

SP

CLOs

Demand drives Euro CLO portfolio loosening

With demand for high-yielding assets outstripping supply, more European CLOs are being issued with atypical, looser portfolios. While investors may be taking on greater risk as a result, spreads are not reflecting this, leaving some wondering whether the compensation is adequate.

Neil Desai, portfolio manager at Highland Capital, says he has seen several European CLOs that have pushed the envelope recently. He comments: "We've seen managers issue deals with higher bond buckets and higher dollar-denominated loans. Issuers are confident that they will be able to sell it without sacrificing pricing levels. This potentially means investors are not getting compensated for that extra risk."

It is important to note, however, that this strategy has so far paid off. Desai adds: "Regarding bond buckets, although this may give investors pause, the managers who utilised higher bond buckets have benefited as high yield has outperformed loans in the recent credit rally."

It isn't just bond buckets and dollar-denominated loans that have been loosening, however. Covenant-lite loan allocations have also increased, with some European CLOs holding 70%-80% cov-lite loan allocations, whereas 30% is nearer the industry standard.

Cov-lite loans are not necessarily an indication of higher risk though. "We've also seen higher cov-lite buckets increase. However, this is less of a concern to us, as there is simply a definition-adjustment of cov-lite in the higher cov-lite CLOs," Desai elaborates.

On top of this, the market has generally continued its trend of tightening across the capital stack. "There isn't much variation in recent pricing, thickness or credit enhancement and CE is pretty stable. The curve in investment grade tranches is relatively flat between refinance deals and new issue deals (assuming Libor floors on both)," Desai notes.

He continues: "Additionally, price tiering among managers has also compressed materially in the IG tranches. It is in the non-IG space where we are seeing more differentiation and relative value. Generally, however, I feel that investors are not getting adequately compensated for taking on additional liquidity risk and duration in new issue deals managed by lesser known managers."

Desai points out that the increase in dollar-denominated loans is mainly coming from experienced US firms. Among other factors, the issuer's track record may be enough to assuage investor concerns.

He adds: "In a recent BlueMountain CLO, it had a higher proportion of dollar-denominated loans. But investors who are familiar with the manager in the US will be comfortable, given BlueMountain's stellar reputation in the US markets, and will believe that the dollar bucket would be an overall benefit to the structure."

In terms of where his firm is finding value at the moment, while it is a hard call, there are pockets of opportunity. "European CLOs are not trading at a discount. There is little differentiation all the way down the capital stack, apart from the lower mezz tranches, where you can pick up some spread," he says.

Furthermore, as spread compression continues, so his firm is varying its approach in the search for yield - potentially away from new transactions. Desai concludes: "Lastly, as we play mostly in the IG-space in Europe, we feel the A-BBB basis has compressed to a point where we are beginning to ask ourselves if we are getting paid for moving down to triple-B in new issue. We think the better play is new issue single-A or refi triple-B (with Euribor floors)."

RB

Structured Finance

SCI Start the Week - 10 July

A look at the major activity in structured finance over the past seven days

Pipeline
Pipeline activity picked up a little last week, but remained fairly muted. Additions consisted of five ABS, five RMBS and a CMBS.

The ABS were €275m Bavarian Sky Europe Compartment Swiss Auto Leases 2, US$227m First Investors Auto Owner Trust 2017-2, US$1bn GM Financial Consumer Automobile Receivables Trust 2017-2, US$857m John Deere Owner Trust 2017-B and SMART ABS Series 2017-2.

A$350m Barton Series 2017-1 Trust, Finsbury Square 2017-2, A$686m Liberty Series 2017-3 Trust, Resimac Premier Series 2017-2 and US$485.25m Sequoia Mortgage Trust 2017-5 were the RMBS. The CMBS was US$671m CGMS 2017-MDDR.

Priced
There were considerably fewer prints than there had been the week before. The last count consisted of four ABS, two RMBS and three CLOs.

€309.7m Brisca Securitisation 2017, €700m Bumper 9 (NL) Finance, US$940.7m Castlelake Aircraft Structured Trust 2017-1 and £473m Globaldrive Auto Receivables UK 2017-A were the ABS. The RMBS were €346.6m Cartesian Residential Mortgages 2 and £443m Residential Mortgage Securities 30, while the CLOs were US$462.2m Atlas Senior Loan Funding 2014-1R, US$468m Benefit Street Partners CLO 2013-3R and €279.3m Cairn CLO BV 2015-5R.

Editor's picks
Atlante II role confirmed in MPS deal: The European Commission has approved a €5.4bn precautionary recapitalisation of Monte dei Paschi di Siena under EU state aid rules, which is conditional on a five-year restructuring plan that includes the disposal of a €26.1bn non-performing loan portfolio via securitisation. Atlante II is expected to share the funding of the junior and mezzanine tranches with an undisclosed group of investors, while the senior note will be sold to private investors...
ESBies unlikely to boost ABS: The securitisation market is unlikely to see any benefit from the issuance of European safe bonds (SBBS or ESBies), despite a recent European Commission paper supporting their development. This follows an earlier proposal to create a European 'safe bond' akin to US Treasury bonds (SCI 26 October 2016), but questions remain over the product's viability, along with investor appetite...
Attica deal unlikely to be replicated: Greek bank Attica has announced a securitisation of €1.3bn of non-performing loans. Although rare, the transaction is unlikely to become a template for larger systemic banks, as control of servicing and the portfolio remains an issue...
Reserve uncertainty weighs on legacy RMBS: It emerged last week that Wells Fargo withheld over US$90m in cashflow across 20 Bank of America-originated legacy non-agency RMBS, which resulted in losses across the capital structure. The move has introduced uncertainty due to legal complications to the sector, unrelated to ongoing collateral performance...

News
• The Basel Committee and IOSCO have released consultative documents outlining criteria for identifying simple, transparent and comparable (STC) short-term securitisations and their proposed capital treatment. The criteria take account of the characteristics of ABCP conduits, such as the short maturity of the CP issued, the different programme structures (multi-seller and single seller) and the existence of multiple forms of liquidity and credit support facilities.
• Banca Carige has launched its keenly-anticipated non-performing loan securitisation (SCI 1 March). Dubbed Brisca Securitization, the €309.7m transaction is backed by an NPL portfolio with a total gross book value of €938.3m.
• Natixis has issued the first-ever 'green' tranche in a CMBS, in collaboration with Ivanhoe Cambridge and Callahan Capital. The US$72m bond was incorporated in the recent CSAIL 2017-C8 transaction and refinanced part of the US$358.6m fixed-rate first mortgage loan provided by Natixis to Ivanhoe Cambridge for the acquisition of the 85 Broad Street building in New York.
• Sears is set to terminate its master lease at 20 unprofitable locations owned by Seritage Growth Properties and vacate the properties in October (SCI 7 April 2015). The move could adversely affect about US$550.4m of loans in associated CMBS.
• Tighter policy guidance is influencing the range of products that UK buy-to-let mortgage lenders are offering. Indeed, some lenders appear to be exploiting the differences in regulatory lending policies across mortgage products - which could lead to unintended risks within BTL RMBS.
• The Annington Group is set to refinance its capital structure, after investors passed an extraordinary resolution last week allowing the firm to redeem its Annington Finance No. 1 and No. 4 CMBS. The move is designed to take advantage of favourable market conditions and is expected to reduce the firm's borrowing costs.

CMBS

Grocery-backed CMBS prepped

Citi and Morgan Stanley are in the market with an unusual US$706.7m CMBS sponsored by Madison International Realty and DDR. Dubbed CGMS 2017-MDDR, the transaction is backed by three separate loans, each secured by a portfolio of predominantly grocery-anchored retail properties located across nine US states.

Unusually, the loans are not cross-collateralised or cross-defaulted. As a result, payments and losses on a particular loan are only expected to impact the related loan-specific certificates. However, given there may be some common management of the properties and borrowers/guarantors may be affiliated, in the event of an adverse impact related to management, the sponsorship or the guarantor, all three loans may be affected.

The pool A loan is a five-year fixed-rate loan, while the pool B and C loans are floating-rate loans with an initial term of two years, followed by three one-year extension options. The US$207.8m pool A fixed-rate certificates, US$261m pool B floating-rate certificates and US$202.5m pool C floating-rate certificates have 79.6%, 77.4% and 83.3% beginning and ending LTV ratios respectively, based on S&P's estimate of the underlying portfolio's value.

The borrowers in the transaction include 55 single-purpose entities organised to own an individual property within each portfolio. The borrowers are 80% owned by Madison Real Estate Liquidity Fund VI through DDR Manatee Master REIT and 20% owned by DDR. DDR Property Management has managed the collateral since 2007 and will continue to manage the properties in the three portfolios for 3% of gross revenue.

Morningstar and S&P have assigned provisional ratings to the transaction of triple-A on the class A notes in all three of the loan pools. For the pool B and C loans, the floating rate is based on Libor or prime rate, but to mitigate borrower exposure to increases in Libor, the loan documents require them to enter into a rate cap agreement with a Libor strike rate.

S&P notes that the transaction is strengthened by relatively low leverage of the trust loan balances for pools A and B, while pool C's is moderate. The rating agency adds that the loans also benefit from high debt service coverage.

Additionally, S&P says that the transaction benefits from the loans being predominately backed by grocery-anchored retail properties. The agency notes that generally grocery stores generate higher sales per square-foot than other retailers of similar store size in similar locations and tend to be less exposed to competition from online retail offerings and, therefore, have a more stable outlook.

On the downside, risks include geographical concentration in pool C, with 16 of the 18 assets being in Florida and the remainder in Georgia. Furthermore, there is concentration by sponsor and property type, with the three loans all made to borrowers owned by the same sponsor - the joint venture between DDR and Madison International Realty.

Nevertheless, S&P says that the properties have shown stable sales, occupancy and NCF performance over the last six years. All of pool C's properties are anchored by Publix Super Markets, which accounts for 44% of the portfolio's rental area, but same store sales for Publix have increased every year since 2013.

RB

CMBS

Mall-backed CMBS defies retail concerns

JPMorgan and Column Financial are in the market with a US$150m CMBS. West Town Mall Trust 2017-KNOX is backed by a commercial mortgage loan secured by the largest enclosed mall in Tennessee.

The transaction is sponsored by a subsidiary of Simon Property Group, which co-owns the West Town Mall property with a subsidiary of Teachers Insurance and Annuity Association of America (TIAA). S&P highlights that the transaction is strengthened by the fact that Simon Property Group is the largest publicly traded owner, operator and developer of retail properties and owns - or has an ownership interest in - 206 properties in the US, including 108 malls.

As well as being the largest enclosed mall in Tennessee, West Town Mall is the dominant one in the Knoxville area, being the only location for 40 national retailers in the MSA - including Apple, Ann Taylor, J Crew, Abercrombie & Fitch, Guess, Coach, Williams-Sonoma and Pottery Barn. There is also relatively low leverage on the mortgage loan at 78.4% LTV ratio and the whole mortgage loan balance has a DSCR of 1.54x, lower than the 1.67x calculated by the issuer.

S&P notes that brick and mortar retail has come under pressure recently and at the property, Rue 21, Regis, Best Buy Mobile and Stride Rite have announced plans to close. These, however, account for less than 2% of the capital and super-regional shopping centres "should be more resilient because they have a diverse group of tenants, strong sponsorship and serve larger trade areas," according to S&P.

Sears, JC Penney and Belk are all major tenants and have lower sales on a per square-foot basis than their respective brand national average. However, Belk has signed a new lease until 2033 and the store has higher sales than the average Belk location. JC Penney has seen sales growth in the last three years and has higher sales on a gross basis than average, while Sears is not part of the collateral.

Furthermore, S&P considers the property's inline occupancy cost to be sustainable, with inline sales at the shopping centre growing annually between 2014 and 2016. The mall benefits from a diverse tenant mix of national anchors, inline retailers and a movie theatre, which lowers the borrowers' reliance on any single tenant's rental income in order to meet the loan's debt service.

S&P notes that the property hasn't been renovated for 20 years. But, as part of the transaction, Simon Property Group has agreed to invest US$15.75m for updates.

S&P has assigned provisional ratings of triple-A to the US$60.705m class A notes, double-A minus to the US$25.46m class Bs, single-A minus to the US$19.095m class Cs, triple-B minus to the US$23.465m class Ds and double-B to the US$13.775m class Es. There is also a notional amount of class X certificates totalling US$86.165m, provisionally rated double-A minus, and an unrated US$7.5m vertically held tranche for risk retention purposes.

RB

Insurance-linked securities

Generali launches cat bond first

GC Securities has priced the first 144A catastrophe bond that provides indemnity protection against multiple European perils and the first to cover European flood. The €200m Lion II Re transaction provides Assicurazioni Generali with four years of per occurrence cover against windstorms and floods affecting selected European countries, as well as earthquakes affecting Italy.

The deal marks the third time that Generali has tapped the ILS market. The sponsor's first cat bond - Lion I, from 2014 (see SCI's primary issuance database) - provided cover in respect of Europe windstorms only, while the issuance in 2016 of Horse Capital I provided cover in respect of increases in the loss ratio of its motor third-party liability business.

Lion II Re has a scheduled maturity of 15 July 2021 and an expected loss of 2.24%. The transaction priced with a coupon of 3%.

Cory Anger, global head of ILS structuring at GC Securities, comments: "Generali's balanced structuring decisions when renewing its prior Lion I coverage through the Lion II cat bond led to an expansion of the covered perils (including into non-modelable territories) and also achieving the first euro-denominated cat bond since 2015, despite negative interest rates in the eurozone. All of this was achieved at the lowest-ever differential between the risk interest spread relative to the insurance risk (annual expected loss) in the history of the 144A cat bond market."

Chi Hum, global head of ILS distribution at GC Securities, adds: "Generali's decision to sponsor Lion II Re away from the typical late-Q3 and/or Q4 timeframe for Europe perils was rewarded with the broad-based and robust support of more than 20 investors that allowed the deal to be priced almost 15% lower than lowest end of initial guidance."

European windstorm coverage is for all countries exposed to the peril, while European flood coverage is for Austria, the Czech Republic, Germany, Hungary, Poland, Slovakia, Switzerland and the UK (excluding Northern Ireland). The notes will attach at €800m of windstorm losses, €1.1bn of flood losses or €600m of Italian earthquake losses.

GC Securities served as lead structurer and sole bookrunner on the deal. Munich Re was co-structuring agent.

Generali says it intends to play a major role in the cat bond market, availing itself of ILS tools in its capital management and risk transfer strategy.

CS

NPLs

Inaugural NPL ABS launched

Credit Valtellinese and Credit Siciliano have tapped the market with their first Italian non-performing loan securitisation. Dubbed Elrond NPL 2017, the €526.6m transaction is backed by an NPL portfolio with a gross book value (GBV) of €1.405bn, of which €30.8m is cash in court.

The collateral comprises loans extended to 3,682 defaulted borrowers and is a mix of secured residential and commercial loans with an approximate GBV of €1.033bn and unsecured loans with an approximate GBV of €372.4m. There are also €57.5m of assets with a senior claim.

Individual borrowers make up 12.9% of GBV, while corporate borrowers comprise 57.8% of GBV. Of the loans in the collateral pool, 34.9% are in the process of foreclosure, 57.8% are in the process of bankruptcy and 7.2% are in another type of resolution (or none has been initiated).

Moody's and Scope have assigned ratings to the transaction of Baa3/BBB- on the €464m class A notes and B1/B+ on the €42.5m class Bs, but have not rated the €20m class J notes. The A and B notes are floating rate, while the J notes are a mix of floating and variable rate. All are due July 2040.

The class A, B and J notes account for 33%, 3% and 1.4% of GBV respectively. The coupon on the notes comprises six-month Euribor plus 0.50%, 6% and 10% respectively.

The portfolio will be serviced by Cerved Credit Management (CCM) as special servicer and Securitisation Services as master servicer. Cerved Master Services (CMS) has requested authorisation from Bank of Italy to be registered as a financial intermediary and, if granted before 31 March 2018, CMS will replace Securitisation Services as master servicer.

Moody's notes that the transaction benefits from the presence of a special servicer, as this has led to better recovery rates for previous NPL transactions, particularly where the special servicer carries out servicing activities rather than the originator. The interest rate cap of six-month Euribor also supports the deal, with Banca IMI and JPMorgan providing the cap.

Furthermore, the rating agency says that the special servicer has set up a detailed business plan, specifying recovery strategy, expected recovery proceeds and timing on collection for each portfolio. Zenith Service will monitor servicing activities performed by CCM and Securitisation Services and the latter will take over the role of master servicer if CMS's role is terminated.

Risks to the transaction include irregular cashflows resulting in no regular payments to the SPV, while the issuer must still pay interest to noteholders and senior fees. This lumpiness is mitigated by the cash reserve, which at the strike cap would be enough to cover 18 months of interest on the class A notes and more senior items.

There is also obligor concentration, with around 6.6% of the pool concentrated in the top 10 obligors, and the impact on the cashflows could be substantial if recoveries on these positions are slower or less than expected. Furthermore, Moody's points out that 4.1% of the loans in terms of GBV are secured by a second or lower ranking lien mortgage, which often results in lower recovery rates.

Additionally, the portfolio has high exposure to land, with around 8.2% of the secured loans and 6% of the total GBV consisting of loans secured by land. Such loans typically have more volatile recovery rates. Furthermore, 9.8% of the secured loans are backed by hotel and leisure properties, which typically have a lower sale price in auction compared to other property types.

Banca IMI, JPMorgan and Mediobanca arranged the deal. BNP Paribas is agent bank, account bank, principal paying agent and cash manager.

RB

NPLs

NPL secondary market impediments eyed

The European Commission has launched a public consultation regarding initiatives to facilitate the development of a non-performing loan secondary market. Together with gathering targeted input on improving loan transfers and servicing activities, the consultation introduces a potential new instrument - dubbed the accelerated loan security - that aims to increase the protection of secured creditors from borrower defaults.

Removing impediments to NPL secondary markets is one policy option put forward by the Commission's Financial Services Committee, which established a dedicated subgroup in 2H16 to develop a comprehensive strategy to tackle the European NPL problem in line with Capital Markets Union (CMU) objectives. The aim is to strengthen the transfer and ownership of these assets by banks and non-banks, while safeguarding consumer rights, as well as to simplify and potentially harmonise the licensing requirements for third-party loan servicers.

Distressed debt markets tend to be characterised by comparatively small trade volumes, a limited number of active investors and large bid-ask spreads. This reflects various factors, such as significant differences in the required rates of return for banks and investors and in loan recovery expectations, as well as how servicing costs are taken into account.

Public policy could therefore assist by alleviating specific impediments that constrain the sale and transfer of loans. The Commission points out that while few explicit national restrictions on NPL sales and transfers have been identified, there are instances of more indirect restrictions - for example, loan transfers are limited to either banks, financial institutions or require country-specific and licensing procedures.

In some member states, the acquisition of receivables requires a financial institution license, whereas a license is not required for debt collecting activities. In others, specific rules govern the transfer of NPLs - with the aim of protecting specific borrowers - and there may be differences in the rights and obligations transferred to the party acquiring the NPLs. More stringent rules apply in some instances to cross-border transactions, as well as the ability of non-banks to restructure NPLs.

Further, the lack of independent servicing capacity in some markets may hinder the development of liquid secondary markets for distressed debt. When banks sell defaulted loans, third-party servicers represent an alternative to managing those loans on behalf of investors, which usually do not have any capacity to service NPLs.

The consultation states that an appropriate common EU approach would establish a clear legal and regulatory regime, which currently varies across jurisdictions in terms of status (financial intermediary, debt enforcement or debt receivables companies) and licensing (by the central bank/supervisor or registration with judicial authorities). It adds that to this end, harmonisation of principles guiding servicing activities and the transfer, ownership and management of NPLs by bank and non-bank investors is warranted.

The existence of well-developed secondary markets would "improve liquidity and reduce volatility when pricing NPLs, and diminish the 'threshold' effect associated with the current state of play in secondary markets, whereby banks seem to be willing to engage with buyers only when the NPL level has reached levels that are deemed undesirable or unsustainable."

Meanwhile, in connection with strengthening Europe's banking system against the accumulation of future NPLs, an 'accelerated loan security' may equip EU banks with a swift, out-of-court power to foreclose on their collateral on the basis of the loan contract concluded with business borrowers. The rationale of backing bank loans with such a security right is to protect the bank in case of a borrower's default.

Only some member states grant special statutory rights to banks that can be understood as security rights. The fragmented legal framework and the inefficiency of the judicial system in collateral enforcement represent vulnerabilities for bank stability, according to the Commission, with a negative impact also on the capacity of financial institutions to provide lending.

The core features of the accelerated loan security would be the 'accelerating clause' and the 'out-of-court enforcement' mechanism, which would offer banks a new kind of collateral that might be added to the spectrum of securities rights. "Collateral givers would benefit from the advantage of increased options and conditions (e.g. obtaining lower interest rates) to secure their loans and easier access to finance. At the same time, banks may benefit from their enhanced power to recover and realise value from unpaid loans, safeguarding their priority right faster than in ordinary in-court enforcement," the consultation states.

Evidence-based feedback and specific suggestions on the consultation are invited by 20 October. If the feedback confirms the potential usefulness of addressing impediments to an NPL secondary market, a legislative initiative will be targeted for 1Q18.

CS

RMBS

Ratings reviewed for payment disruption risk

Fitch and Moody's have placed a slew of US RMBS classes on rating watch negative, after Wells Fargo withheld trust funds to reserve against future expenses it may incur to defend itself against litigation (SCI 3 July). The actions are primarily due to the trustee's allocation of losses following transaction clean-up calls, which resulted in noteholders failing to receive expected payments. PIMCO is reportedly suing Wells Fargo over the move.

The bank indicated that the withheld reserves are intended to cover future expenses related to lawsuits initiated in 2014 by institutional investors that claim they were damaged when Wells Fargo did not fulfil its obligation as trustee to protect them from defective mortgages. The bank's action is notable due to its pre-emptive nature and the magnitude of the amounts withheld. Fitch suggests that the legality of the action is likely to be challenged with further litigation.

Most structured finance transactions permit trustees to use trust funds in certain circumstances to cover expenses related to litigation involving the trusts. However, Moody's notes that whether such circumstances have been satisfied in the transactions subject to the rating actions remains an "open question".

To date, trustees have typically only withheld funds to cover expenses actually incurred or reserves in amounts not large enough to affect credit ratings.

Fitch is reviewing 299 US RMBS classes from 98 transactions - totalling US$2.2bn of bonds - while Moody's is reviewing 105 tranches from the 12 affected Bank of America deals. These are Banc of America Alternative Loan Trust 2004-1, 2004-2, 2004-3, 2004-4 and 2004-8, Banc of America Mortgage 2004-10 and 2005-1, and Banc of America Mortgage Securities Series 2005-6, 2005-7, 2005-9, 2005-10 and 2005-12.

Moody's says it placed the affected tranches on review for possible downgrade because although the tranches have incurred losses, there is a possibility that noteholders will receive some funds in the future. Wells Fargo notified investors that it plans to distribute unused reserve funds when it determines that those funds are no longer necessary to meet current or future expenses in connection with the litigation.

"Although the trustee has withheld amounts that appear significant for each deal, particularly when considering the number of loans that already have paid off in full, both the amount of funds that could become available for certificateholders and the timing of the release of such funds is uncertain," Moody's observes. "Furthermore, it is unclear how holders would recoup forgone interest payments. Even more fundamentally, in light of the investor litigation against the trustee, it is unclear whether the trustee ultimately will be entitled to use trust funds to cover its litigation costs or if it will be required to reimburse the transactions."

The tranches placed on negative watch by Fitch include 55 classes from 17 transactions that have already been affected by Wells Fargo's actions, as well as 244 classes from 81 transactions that share similar characteristics with the affected classes and are at risk for payment disruption in the future. The bank withheld approximately US$79m from 17 Fitch-rated transactions that were called on the June 2017 distribution date. The redirection of trust funds resulted in insufficient remaining funds to pay off 55 Fitch-rated classes, including six classes with investment grade ratings.

The amount withheld from the 17 called transactions reflects an assumption by Wells Fargo of future legal expenses of US$3,000 per loan originally in the trust, plus US$130,000 for each transaction. Fitch assumes the bank will continue to pre-emptively redirect trust funds to reserve against future expenses in scenarios where it may not be able to reimburse itself from the trust in the future, such as when a transaction is called or when the remaining pool balance is relatively small, although the withholding amount may vary in the future.

Fitch's rating analysis will make credit distinctions to reflect the risk of payment disruption from withholding amounts. For instance, the ratings of the 55 classes that did not recover full principal payments in the recently called transactions are likely to be lowered to single-D. The agency notes that while some classes may ultimately recover their full principal amount, the lack of interest payments on the withheld principal payment will still result in a default under its rating definitions.

The risk to the remaining outstanding classes will vary based on the pool size, credit enhancement and whether the transaction is called. Fitch indicates that transactions in litigation that are currently callable and include bonds with credit enhancement that is less than an estimated future withholding amount (based on an assumption of US$3,000 per loan and US$130,000 per transaction) are at greatest risk.

Lacking additional information or further guidance from Wells Fargo, ratings on such classes may be limited to non-investment grade levels and possibly no higher than single-B. The agency notes that 202 of the 299 classes placed on negative watch fall into this category, including 44 investment grade classes.

At next greatest risk are classes with credit enhancement that is less than the estimated future withholding amount, but within transactions that are not yet callable. Ratings on such classes may be limited to non-investment grade ratings, possibly no higher than double-B. Of the 299 classes placed on watch, 27 fall into this category, none of which are currently higher than single-A.

Finally, ratings on some classes with credit enhancement that is greater than the estimated future withholding amount may also be revised to reflect the fact that credit enhancement will decline over time and that the future withholding amount assumption is only an estimate. Fitch explains that ratings were placed on watch if the relationship multiple of credit enhancement to the estimated future withholding amount was less than 2x, 1.75x, 1.5x, 1.25x, 1.1x and 1.05x for existing ratings of triple-A, double-A, single-A, triple-B, double-B and single-B respectively.

Ratings on classes with insufficient cushions to the estimated withholding amounts may be revised accordingly. Of the 299 classes placed on watch, 15 fall into this category, including eight investment grade classes.

Fitch says it has also contacted the other five trustees named in the legacy RMBS lawsuits, but they were unwilling or unable to provide guidance on whether they intend to follow a similar strategy to Wells Fargo in respect of the amount and the pre-emptive nature of withholding against future expenses. The agency adds that is working to identify the trusts named in major lawsuits against the other five trustees and is conducting a similar rating analysis of comparing credit enhancement to a reserve amount based on Wells Fargo's assumptions.

Fitch expects to resolve the rating watch status of the Wells Fargo-affected tranches within 30 days.

CS

Structured Finance

Job swaps round-up - 14 July

North America

Mortgage Capital Trading has hired Bill Berliner to the newly created role of director of analytics. He was previously mortgage community manager at Thomson Reuters.

BlueMountain Capital Management has hired Lee Kempler as coo for investments. He was previously md at Blackrock.

FS Investments has hired Michael Carter as evp, head of strategy. He will be based in the firm's headquarters in Philadelphia and was previously coo at Magnetar Capital.

Robert Weiss has joined Northleaf Capital Partners as senior advisor on the private credit team, based in Chicago. He recently retired from Sankaty Advisors, where he had been md and head of the Chicago office, with responsibilities for sourcing, diligencing, structuring and negotiating senior debt, mezzanine and equity investments for the firm's middle market direct lending business. Before that, Weiss was a consultant at The Boston Consulting Group.

Conyers Dill & Pearman has hired James Denham as associate in the corporate department in the firm's Cayman Islands office. He was previously at Allen & Overy in the derivatives and structured finance team.

EMEA

Kevin Flaherty has launched a new fund called Neptune Capital as managing partner, based in London. He was previously head of syndicate at SCIO Capital.

Nomura has hired Fred Jallot as head of global markets, EMEA. He will be based in London and report to Steve Ashley, head of wholesale and global markets, and Jonathan Lewis, head of EMEA. Previously, Jallot was EMEA head of trading and structuring at Citi.

Mark Gibson has joined Neon Underwriting as reinsurance and alternative capital director, based in London. He was previously director of alternative risk markets at Argo Group International and has also worked in insurance/risk solutions at BNP Paribas and Guy Carpenter. Among his specialties are ILS and collateralised reinsurance products.

Fitch has appointed Karen Skinner to the newly created role of chief operating officer, based in London. Prior to this, Skinner was responsible for Fitch Group's strategy and business intelligence team.

Barclays has hired Pratik Gupta and Sebastian Buhs as vps in its ABS sales and trading group. Gupta was previously in the private equity division of Park Street Advisors, while Buhs joins from Chalkhill Partners, where he worked in sourcing, sales and debt advisory.

Citi has promoted Amit Raja to head of EMEA credit markets trading, in addition to his current role of head of European leveraged trading. He was previously global head of distressed trading since 2014, but this team will now report to Brian Archer.

Acquisitions

Bayview Asset Management is set to acquire Pingora Holdings, a Delaware limited partnership and wholly-owned indirect subsidiary of Annaly Capital Management. Through its subsidiaries Pingora Asset Management and Pingora Loan Servicing, the firm operates as a specialised asset manager focused on investing in new production performing MSRs and servicing residential mortgage loans. The acquisition is subject to customary closing conditions and is expected to close in Q3.

MetLife is set to acquire Logan Circle Partners, Fortress Investment Group's traditional fixed income asset management business, for approximately US$250m in cash. The firm is a fundamental research-based investment manager, providing institutional clients actively managed investment solutions across a broad spectrum of fixed income strategies. It had over 100 institutional clients and more than US$33bn in assets under management, as of 31 March.

CLO name change

Apollo Credit Management plans to refinance six classes of its ALM X CLO next month and simultaneously rename the replacement notes RR 1. The transaction will be managed by Redding Ridge Asset Management, a capitalised management vehicle (CMV) established by Apollo in 2016 to comply with US and Europe risk retention rules. Together with the re-assignment of the collateral manager role, the senior and subordinated management fee is expected to increase.

Settlement

The FHFA has reached a settlement with RBS, related companies and specifically-named individuals for US$5.5bn, resolving all claims in the lawsuit FHFA vs. The Royal Bank of Scotland Group plc et al. in the US District Court for the District of Connecticut. The FHFA alleged violations of federal and state securities laws in connection with private-label RMBS bonds purchased by Fannie Mae and Freddie Mac between 2005 and 2007. Under the terms of the agreement, RBS will pay approximately US$4.525bn to Freddie Mac and US$975m to Fannie Mae.

Legislation

The CFPB this week announced a new rule banning companies from using mandatory arbitration clauses to deny groups of investors from bringing class action lawsuits, in a move widely seen as credit negative for consumer ABS. Although currently outstanding accounts would not be affected by the final rule, it would increase the risk of class action litigation for sponsors.

However, some believe that the rule may never actually go into effect. The Congressional Review Act (CRA) - which allows regulations issued by government agencies to be overruled - has already been used 14 times this year and may well be used again in this case.